SPX Update: Rally Now Solidly Overbought

Well, yesterday's preferred very short-term interpretation of an ending pattern was a miss, but I hope I at least conveyed my trepidation over that interpretation.  As I wrote yesterday:

There's no clear third wave in this mess (the third wave is almost always the longest and strongest wave) -- and that tells me it's either an ending pattern, or a wind-up to launch (meaning the strong third wave is yet to come). I realize one could look at the chart and say, "But you have red (iii) labeled, and it's the longest and strongest!" Yes, it is. But it's not a "proper" third wave -- there's too much price overlap. And it's bothering me.

It now appears that it was, in fact, the potential wind-up pattern I was worried about, and the 2nd tier targets (1365-1375) were very nearly reached.  The good news is that yesterday's action has finally eliminated some of the potentials, which makes things at least a bit easier -- for example, the possibility of a higher degree fourth wave is now firmly off the table.  We are therefore most likely dealing with a second wave rally.  I say "most likely" because we can never completely rule out anything in trading; we are always working solely with probabilities... so it's always possible this rally is the start of something bigger.  But these two options should be relatively easy to sort from each other going forward. 

To do so, we'll watch the key levels, and we'll watch out for an impulsive wave structure (a five wave form) in the upwards direction.  If we see an impulse wave develop here, we can then shift footing and assume we're dealing with a new uptrend -- and buy the next dip.  But if the rally maintains its present corrective structure (it's currently 3-waves), we can have high confidence that the trend remains down.  Based on the form of the decline and the key overlap at 1292, I continue to believe this is the case, unless and until the market proves otherwise.

Of course, if Ben "the Beard" Bernanke announces QE3, we can probably pretty much just assume the market is going to infinity (possibly higher).

So, let's look at some of the signals and some key price levels. 

The first signal of note is the McClellan Oscillator (NYMO), which is a breadth indicator, and one of my favorites.  Readers will recall I have cited this indicator's buy signals twice in recent months, and both came at bottoms which led to solid rallies (on May 18 and April 11).  NYMO has now reached overbought levels, which is a sell signal.  We can see on the chart that sell signals tend to lead tops, but all five prior instances have still been been profitable sells.

Moving on to the short-term SPX chart, it's not inconceivable that 1363 was the peak, but my best guess is that there's still new highs lurking out there for this wave.  This would tend to be supported by the past behavior of NYMO mentioned above.  Third tier targets (1400-1410) will open if the market can sustain trade over 1375.

 

No change yet to the intermediate picture: the strength of this rally is not unexpected from an intermediate perspective.  It's been a challenge figuring out some of the short-term structures (as it usually is), but so far the rally fits the intermediate expectations for wave (ii) perfectly. 

In conclusion, wave (ii) may be nearing completion -- but it wouldn't be out of the question for it to make a run at the higher targets.  As mentioned on several previous occasions, bulls continue to have the ball until the bears can break the lower boundary of the red trendchannel.  Trade safe.

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